Johnson Controls Is an Attractive Investment Opportunity

Brian Bernard: We continue to view narrow-moat Johnson Controls as an attractive investment opportunity. Following its transformative merger with Tyco and its spin-off of its automotive seating business in 2016, Johnson Controls has become a more profitable and less cyclical company, and the firm remains on track to realize over $1 billion in cost synergies by fiscal 2020.

Still, shares have underperformed since the company's transformation leaving shareholders frustrated. However, we think the market has been too focused on the company's recent performance, which has been choppy in part due to its integration efforts with Tyco, and the market is missing the longer-term picture. Based on our analysis, we believe Johnson Controls' building technologies business has one of the most comprehensive product portfolios in the industry. Only United Technologies has a similar product portfolio that spans across commercial HVAC, building automation and controls, and fire and security, and United Technologies is facing activist pressure to sell or spin-off this business. If this happens, we think Johnson Controls could take advantage of disruption at a key competitor.

If Johnson Controls can achieve its cost synergy target, we believe its buildings segment can generate operating margins that are in line or above peers such as Ingersoll Rand and Lennox. Over the next couple of years, we think Johnson Controls can continue to improve its buildings margins, while peers struggle to maintain what we view as peak margins.

In early March, Johnson Controls announced it is exploring strategic alternatives for its power solutions business. Power solutions is the leading global manufacturer of automotive lead-acid batteries. While we've always liked this business, which is the crown jewel in the lead-acid battery market, the fact of the matter is, Johnson Controls is currently not receiving a fair valuation for its buildings and power solutions businesses as a combined entity. Based on our analysis, we believe power solutions is worth about $19 billion, and we think an outright sale of the business for a fair price could be the fastest path to creating shareholder value. That said, we think a joint venture relationship with the right strategic partner or spinning off the business could also create shareholder value.